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What’s A Roth Conversion

 You can expect to read and hear a lot more about taxes in the coming months as Congress battles it out over the President’s proposed budget.  

While it is generally accepted there will be some increase in taxes for many people, no one knows for sure what the final outcome will be.  The uncertainty makes it more difficult to plan ahead. 

 One planning idea you may hear about is a Roth Conversion.  Under the right circumstances it can be a timely tax saving strategy albeit, probably not for most people.

 Let’s back up.

Retirement plans like an IRA or 401(k) give you a tax deduction when you contribute to them, and then they grow and grow without any taxes.  However, when you start to withdraw money from them, that amount is taxed at your ordinary income tax level. 

 For most people this is a good tradeoff.  You get a tax saving deduction while you are working and when you do start to take money out, you are expecting to be in a lower tax bracket.

 As good as that sounds, for a few people it could make more sense to put those contributions into a Roth retirement account instead.  Why?  Because while you will not get an immediate tax deduction on your contribution as you do using the regular IRA, when you take money out of a Roth IRA it comes out tax free.

 But Congress did not want to make this vehicle available for high end earners who were in a high tax bracket and would still be in a high tax bracket when they retired.  So, they put income limitations on who could actually make annual contributions to a Roth IRA.   

 But there is currently no rule that would stop anyone from taking all or part of their money from a regular IRA, paying taxes on the amount withdrawn and then converting, that is, moving it into a Roth IRA.

 But you need to consider the big tax bill you would have in the year you make the conversion and that is why few people do this. 

 For example, say you have an IRA that is worth $200,000.  If you decide to convert from the regular IRA to the Roth IRA, the $200,000 will be added to your taxable income that year.  Sure, you can take money from other accounts to pay the tax bill so you can convert all $200,000, but you still have given up a large sum of money to the IRS that would have been growing if you hadn’t.

 So obviously one very important factor to consider is whether there is enough time for the money to grow in the Roth IRA to make up for the taxes you have paid making the conversion.

So who might still consider this strategy?

 If your situation has changed and you believe when you retire you will actually not be in a lower tax bracket but in a top tax bracket.

 Another situation where it might make sense is if you do not think you will ever need the money and plan to leave it to your children.  By moving to a Roth IRA you will not be forced to take money out each year based on the required minimum distribution rules and having to pay taxes on money you don’t need, leaving less for your heirs.

 If you have any interest in financial ideas such as this, contact us for a discussion, but decisions involving tax strategies should include your accountant. 

Seeking Higher Income Today - Part 1

Many of our clients worked hard to build their assets and now are relying on those assets to give them the income to enjoy their retirement years.

When interest rates are higher, it is easier to build a portfolio of relatively risk free bonds that will pay enough interest to meet their income needs.  This can be made even safer by using individual bonds as opposed to bond funds, and having a number of the bonds mature every year to reinvest the principal at current interest rates.

Because this is a straight forward strategy and because of our structure, we are able to buy the bonds for their portfolio directly from institutional trading desks - without adding any cost to the bond so their yield is higher.  This is typically not the case for people who use brokers or advisors at brokerage firms.

However, with the world today experiencing unusually low interest rates, the challenge is finding ways to generate income with bonds paying so little interest. Sometimes we need to consider other strategies.

There are preferred stocks with their higher yields and in some cases partial tax advantage payments.  Option writing strategies.  Stocks of large cap companies with dividends paying many times more than CDs.  There are even municipal bonds that pay taxable interest, as opposed to the usual tax free, that work out to be a better choice.

But these have to be approached carefully, as once you leave the strategy of buying individual, high quality bonds, while you can definitely get more income, there are trade-offs.  In some cases, it might be more interest rate risk that could diminish your investment.  In other cases, it might be market risk and volatility that needs to be considered.

Our job at Royal Capital Management and as fiduciaries, is to know the trade-offs and added risk involved.  That’s what we have been doing for the past 45 years.

In the next part of our series on income we will discuss how newly designed annuities can produce an income stream without market or interest rate risk. 

We will explore the special feature a few have that can increase the amount of money received over time to protect against inflation, etc.  For many, we find this can be the perfect fit with the rest of their investment portfolio to ensure a safe, comfortable retirement.

As always, contact us with any of your questions and we will be more than ready to explain the advantages and disadvantages of each strategy.

Seeking Higher Income in Retirement - Part 2

In this Part 2 of income options we will continue our discussion of some of the best income ideas, but this time with emphasis on making the income predictable and not having to worry about market or interest rate risks.

And that is because when we are young and have plenty of time to earn more money, people usually find it much easier to take risk.  But once a person stops working and is relying on their assets to give them the income they need for their planned lifestyle, any risk of losing part of their nest egg becomes serious.

As a Certified Financial Planner™ when it comes to retirement income planning, I generally like to recommend a solid base of income that will always come in no matter what, so there are no worries of paying necessary bills now or in the future.  Once this is done it becomes easier to move other assets to ideas discussed in Part 1 which can produce considerably more income and appreciation but come with some amount of volatility and risk.

Social security, and for some an added company pension, can provide the money to meet basic fixed expenses, but if more is needed then we need to add a steady stream of income using an insurance company annuity.  In the simplest terms, with an annuity a person places a sum of money to an insurance company for the assurance they (individual or a couple) will receive a steady stream of income either for a specific length of time or for the rest of their lives.

I might interject here, that some people say they have heard annuities have a lot of hidden costs.

First, lumping all annuities together is like lumping all mutual funds or bonds.  There are so many different types of annuities just as there are of mutual funds and bonds.  And as far as cost, it varies from one type of annuity to another and to the benefit they are giving.  Naturally, as with other financial products, the best decisions are made after examining the benefit received for the cost and then comparing that cost for the best value.      

There are different classes of annuities such as fixed annuities and variable annuities (be aware the latter tends to have higher expenses). 

There are annuities designed to give you some growth on your money when the stock market goes up and yet never go down when the market has a negative year.

But because we are looking for steady income to go along with social security, we are going to look at an income oriented annuity.

And this is where it can get complicated.  Even after you do select the right kind of annuity, you then have to compare that specific structure of annuity among any number of different companies.

Then within that structure there can be any number of variations.  This is why you will more than likely need assistance from a fiduciary – not a sales person – to make sure you choose the right one.

For example, if this income stream is going to be necessary for possibly a very long time to cover either a person or a couple for the rest of their lives, just like social security, then one of the features we will be looking for is an annuity that has the ability to increase the amount of monthly income over time.

We believe the protection from this feature, of increasing income, is very important so the initial amount you receive doesn’t become inadequate as taxes, inflation, health care costs rise over the years. 

But even this key benefit is structured differently by different companies that do offer it.  So, again a detailed analysis and thorough understanding of how it works is necessary.

This is where we come in.  We have experience with annuities going all the way back to the mid 70’s and as fiduciaries we always find the best solution for you.  And you know, “In the end you have my promise, next to you, no one will work harder or care more about your money.”